Testimony The Budget and Economic Outlook: 214 to 224 Douglas W. Elmendorf Director Before the Committee on the Budget U.S. House of Representatives February 5, 214 This document is embargoed until it is delivered at 1: a.m. (EST) on Wednesday, February 5, 214. The contents may not be published, transmitted, or otherwise communicated by any print, broadcast, or electronic media before that time. CONGRESS OF THE UNITED STATES
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Chairman Ryan, Congressman Van Hollen, and Members of the Committee, thank you for inviting me to testify on the Congressional Budget Office s ( s) most recent analysis of the outlook for the budget and the economy. My statement summarizes s new economic forecast and baseline budget projections, which cover 214 to 224. Those estimates were released yesterday in the report titled The Budget and Economic Outlook: 214 to 224. The federal budget deficit has fallen sharply during the past few years, and it is on a path to decline further this year and next year. The Congressional Budget Office () estimates that under current law, the deficit will total $514 billion in fiscal year 214, compared with $1.4 trillion in 29. At that level, this year s deficit would equal 3. percent of the nation s economic output, or gross domestic product (GDP) close to the average percentage of GDP seen during the past 4 years. As it does regularly, has prepared baseline projections of what federal spending, revenues, and deficits would look like over the next 1 years if current laws governing federal taxes and spending generally remained unchanged. Under that assumption, the deficit is projected to decrease again in 215 to $478 billion, or 2.6 percent of GDP (see Table 1). After that, however, deficits are projected to start rising both in dollar terms and relative to the size of the economy because revenues are expected to grow at roughly the same pace as GDP whereas spending is expected to grow more rapidly than GDP. In s baseline, spending is boosted by the aging of the population, the expansion of federal subsidies for health insurance, rising health care costs per beneficiary, and mounting interest costs on federal debt. By contrast, all federal spending apart from outlays for Social Security, major health care programs, and net interest payments is projected to drop to its lowest percentage of GDP since 194 (the earliest year for which comparable data have been reported). The large budget deficits recorded in recent years have substantially increased federal debt, and the amount of debt relative to the size of the economy is now very high by historical standards. estimates that federal debt held by the public will equal 74 percent of GDP at the end of this year and 79 percent in 224 (the end of the current 1-year projection period). Such large and growing federal debt could have serious negative consequences, including restraining economic growth in the long term, giving policymakers less flexibility to respond to unexpected challenges, and eventually increasing the risk of a fiscal crisis (in which investors would demand high interest rates to buy the government s debt). After a frustratingly slow recovery from the severe recession of 27 to 29, the economy will grow at a solid pace in 214 and for the next few years, projects. Real GDP (output adjusted to remove the effects of inflation) is expected to increase by roughly 3 percent between the fourth quarter of 213 and the fourth quarter of 214 the largest rise in nearly a decade. Similar annual growth rates are projected through 217. Nevertheless, estimates that the economy will continue to have considerable unused labor and capital resources (or slack ) for the next few years. Although the unemployment rate is expected to decline, projects that it will remain above 6. percent until late 216. Moreover, the rate of participation in the labor force which has been pushed down by the unusually large number of people who have decided not to look for work because of a lack of job opportunities is projected to move only slowly back toward what it would be without the cyclical weakness in the economy. Beyond 217, expects that economic growth will diminish to a pace that is well below the average seen over the past several decades. That projected slowdown mainly reflects long-term trends particularly, slower growth in the labor force because of the aging of the population. Inflation, as measured by the change in the price index for personal consumption expenditures (PCE), will remain at or below 2. percent throughout the next decade, anticipates. Interest rates on Treasury securities, which have been exceptionally low since the recession, are projected to increase in the next few years as the economy strengthens and to end up at levels that are close to their historical averages (adjusted for inflation). Deficits Are Projected to Decline Through 215 but Rise Thereafter, Further Boosting Federal Debt Assuming no legislative action that would significantly affect revenues or spending, projects that the federal budget deficit will fall from 4.1 percent of GDP last year to 2.6 percent in 215 and then rise again, equaling about 4 percent of GDP between 222 and 224. That pattern of lower deficits initially and higher deficits for the rest of the coming decade would cause federal debt to follow a similar path. Relative to the nation s output, debt held by the public is projected to decline slightly between 214 and 217, to 72 percent of GDP, but then to rise in later years, reaching 79 percent of GDP at the end of 224. By comparison, as recently as
4 THE BUDGET AND ECONOMIC OUTLOOK: 214 TO 224 FEBRUARY 214 Table 1. s Baseline Budget Projections Total Actual, 215-215- 213 214 215 216 217 218 219 22 221 222 223 224 219 224 In Billions of Dollars Revenues 2,774 3,29 3,35 3,481 3,631 3,77 3,932 4,14 4,288 4,49 4,72 4,926 18,12 4,63 Outlays 3,454 3,543 3,783 4,2 4,212 4,425 4,684 4,939 5,2 5,522 5,749 6, 21,124 48,534 Deficit (-) or Surplus -68-514 -478-539 -581-655 -752-836 -912-1,31-1,47-1,74-3,5-7,94 On-budget -72-553 -54-555 -583-641 -719-775 -821-97 -886-871 -3,1-7,261 Off-budget a 4 38 26 16 2-14 -34-61 -91-124 -16-23 -3-642 Debt Held by the Public at the End of the Year 11,982 12,717 13,263 13,861 14,57 15,218 16,28 16,925 17,899 19,1 2,115 21,26 n.a. n.a. As a Percentage of Gross Domestic Product Revenues 16.7 17.5 18.2 18.2 18.1 18. 18. 18. 18.1 18.1 18.2 18.4 18.1 18.1 Outlays 2.8 2.5 2.9 21.1 21. 21.1 21.4 21.7 21.9 22.3 22.3 22.4 21.1 21.7 Deficit -4.1-3. -2.6-2.8-2.9-3.1-3.4-3.7-3.8-4.2-4.1-4. -3. -3.5 Debt Held by the Public at the End of the Year 72.1 73.6 73.2 72.6 72.3 72.6 73.3 74.2 75.3 76.8 78. 79.2 n.a. n.a. Source: Congressional Budget Office. Note: n.a. = not applicable. a. Off-budget surpluses or deficits comprise surpluses or deficits in the Social Security trust funds and the net cash flow of the Postal Service. the end of 27, such debt equaled 35 percent of GDP (see Figure 1). Revenues Federal revenues are expected to grow by about 9 percent this year, to $3. trillion, or 17.5 percent of GDP just above their average percentage of the past 4 years (see Figure 2 on page 6). Revenues were well below that average in recent years, both because the income of individuals and corporations fell during the recession and because policymakers reduced some taxes. The expiration of various tax provisions and the improving economy underlie s projection that revenues will rise sharply this year. Those factors will increase revenues further in 215, with s baseline showing another 9 percent rise. After 215, revenues are projected to grow at about the same pace as output and to average 18.1 percent of GDP under the current-law assumptions of s baseline. Spending Federal outlays are expected to increase by 2.6 percent this year, to $3.5 trillion, or 2.5 percent of GDP their average percentage over the past 4 years. projects that under current law, outlays will grow faster than the economy during the next decade and will equal 22.4 percent of GDP in 224. With no changes in the applicable laws, spending for Social Security, Medicare (including offsetting receipts), Medicaid, the Children s Health Insurance Program, and subsidies for health insurance purchased through exchanges will rise from 9.7 percent of GDP in 214 to 11.7 percent in 224, estimates. Net interest payments by the federal government are also projected to grow rapidly, climbing from 1.3 percent of GDP in 214 to 3.3 percent in 224, mostly because of the return of interest rates to more typical levels. However, the rest of the government s noninterest spending for defense, benefit programs other than those mentioned above, and all other nondefense activities is projected to drop from 9.4 percent of GDP this year to 7.3 percent in 224 under current law. Changes From s Previous Projections Since May 213, when issued its previous baseline budget projections, the agency has reduced its estimate of this year s deficit by $46 billion and raised its estimate
TESTIMONY THE BUDGET AND ECONOMIC OUTLOOK: 214 TO 224 5 Figure 1. Federal Debt Held by the Public (Percentage of gross domestic product) 12 Actual Projected 12 1 1 8 8 6 6 4 4 2 2 194 1945 195 1955 196 1965 197 1975 198 1985 199 1995 2 25 21 215 22 Source: Congressional Budget Office. of the cumulative deficit between 214 and 223 by $1. trillion. (That 1-year period was the one covered by the previous baseline.) Those changes result from revisions to s economic forecast; newly enacted legislation; and other, so-called technical factors, such as new information about recent spending and tax collections. Most of the increase in projected deficits results from lower projections for the growth of real GDP and for inflation, which have reduced projected revenues between 214 and 223 by $1.4 trillion. Legislation enacted since May has lowered projected deficits during that period by a total of $.4 trillion (including debt-service costs). Other changes to the economic outlook and technical changes have had little net effect on s deficit projections. Economic Growth Is Projected to Be Solid in the Near Term, but Weakness in the Labor Market Will Persist In the next few years, expects, further growth in housing construction and business investment will raise output and employment, and the resulting increase in income will boost consumer spending. In addition, under current law, the federal government s tax and spending policies will not restrain economic growth to the extent they did in 213, and state and local governments are likely to increase their purchases of goods and services (adjusted for inflation) after having reduced them for several years. As a result, projects, real GDP will expand more quickly from 214 to 217 at an average rate of 3.1 percent a year than it did in 213. By the end of 217, the gap between GDP and potential GDP (the maximum sustainable output of the economy) is expected to be nearly eliminated (see Figure 3 on page 7). Between 218 and 224, GDP will expand at the same rate as potential output by an average of 2.2 percent a year, projects. Thus, anticipates that over the 214 224 period as a whole, real GDP will increase at an average annual pace of 2.5 percent. The Economic Outlook Through 217 Real GDP is projected to grow by 3.1 percent this year, by 3.4 percent in 215 and 216, and by 2.7 percent in 217 (see Table 2 on page 8). 1 expects that those increases in output will spur businesses to hire more workers, pushing down the unemployment rate and 1. s economic projections are based on information available through early December 213. Data released since then indicate that the economy grew more rapidly at the end of 213 than had expected. If were completing new economic projections now, it would probably trim its projection of growth for the next few years but make little change to its projections of the level or growth rate of GDP after that.
6 THE BUDGET AND ECONOMIC OUTLOOK: 214 TO 224 FEBRUARY 214 Figure 2. Total Revenues and Outlays (Percentage of gross domestic product) 28 24 Outlays Average Outlays, 1974 to 213 (2.5%) Actual Projected 28 24 2 2 16 12 8 Revenues Average Revenues, 1974 to 213 (17.4%) 16 12 8 4 4 1974 1979 1984 1989 1994 1999 24 29 214 219 224 Source: Congressional Budget Office. tending to raise the rate of participation in the labor force (as some discouraged workers return to the labor force in search of jobs). That effect on participation in the labor force will keep the unemployment rate from falling as much as it would otherwise: projects that the unemployment rate will decline only gradually over the next few years, finally dropping below 6. percent in 217. Nevertheless, the labor force participation rate is projected to decline further because, according to s analysis, the upward pressure on that rate from improvements in the economy will be more than offset by downward pressure from demographic trends, especially the aging of the baby-boom generation. expects that the PCE price index will increase by less than 2. percent a year for the next several years. With such low inflation and considerable slack in the labor market, anticipates that the Federal Reserve will keep short-term interest rates (such as those on 3-month Treasury bills) at their current low levels until mid-215 but that long-term interest rates (such as those on 1-year Treasury notes) will gradually rise as the economy strengthens. The Economic Outlook for 218 to 224 Beginning in 218, s projections of GDP are based not on forecasts of cyclical movements in the economy but on projections of trends in the factors that underlie potential output, including total hours worked by labor, capital services (the flow of services available for production from the nation s stock of capital goods, such as equipment, buildings, and land), and the productivity of those factors. In s projections, the growth of potential GDP over the next 1 years is much slower than the average since 195. That difference stems primarily from demographic trends that have significantly reduced the growth of the labor force. In addition, changes in people s economic incentives caused by federal tax and spending policies set in current law are expected to keep hours worked and potential output during the next 1 years lower than they would be otherwise. Although projects that GDP will expand at the same rate as potential GDP, also projects, on the basis of historical experience, that the level of GDP will fall slightly short of its potential, on average, from 218 through 224. The unemployment rate is expected to edge down from 5.8 percent in 217 to 5.5 percent in 224 because factors associated with the persistently high long-term unemployment experienced in recent years are expected to have diminishing effects on the unemployment rate after 217. As measured by the PCE price index, both inflation and core inflation (which excludes the prices of food and energy) are projected to average 2. percent a year between 218 and 224. Interest rates on 3-month Treasury bills are projected to average 3.7 percent during those years, and rates on 1-year Treasury notes are projected to average 5. percent.
TESTIMONY THE BUDGET AND ECONOMIC OUTLOOK: 214 TO 224 7 Figure 3. GDP and Potential GDP (Trillions of 29 dollars) 24 Actual Projected 2 16 Potential GDP GDP a 12 8 2 25 21 215 22 Sources: Congressional Budget Office; Bureau of Economic Analysis. Notes: Potential gross domestic product (GDP) is s estimate of the maximum sustainable output of the economy. Data are quarterly. Actual data are plotted through the second quarter of calendar year 213; projections are plotted through the fourth quarter of 224. Those projections, which are based on information available through early December 213, do not reflect recently released data that show a higher level of GDP during the second half of 213 than had expected. If the projections were updated to incorporate those recent data, the gap between GDP and potential GDP would be slightly narrower in the second half of 213 and in the next few years. a. From 218 to 224, the projection for GDP falls short of that for potential GDP by one-half of one percent of potential GDP.
8 THE BUDGET AND ECONOMIC OUTLOOK: 214 TO 224 FEBRUARY 214 Table 2. s Economic Projections for Calendar Years 214 to 224 Projected Estimated, Forecast Annual Average, 213 214 215 216 217 218-224 Fourth Quarter to Fourth Quarter (Percentage change) Real Gross Domestic Product 2.1 3.1 3.4 3.4 2.7 2.2 Inflation PCE price index.9 1.5 1.7 1.8 1.9 2. Core PCE price index a 1.1 1.6 1.8 1.9 1.9 2. Consumer price index b 1.2 c 1.9 2.1 2.1 2.3 2.4 Core consumer price index a 1.7 c 1.9 2.2 2.2 2.3 2.3 Fourth-Quarter Level (Percent) Unemployment Rate 7. c 6.7 6.3 6. 5.8 5.5 d Calendar Year Average (Percent) Interest Rates Three-month Treasury bills.1 c.2.4 1.8 3.3 3.7 Ten-year Treasury notes 2.4 c 3.1 3.7 4.3 4.8 5. Source: Congressional Budget Office. Notes: Estimated values for 213 do not reflect the values for gross domestic product and related series released by the Bureau of Economic Analysis since early December 213. PCE = personal consumption expenditures. a. Excludes prices for food and energy. b. The consumer price index for all urban consumers. c. Actual value for 213. (Actual values come from the Bureau of Labor Statistics and the Federal Reserve.) d. Value for 224.